PayPal made strides towards being a Super App

PayPal amplified its efforts to become THE Super App for consumers’ financial needs with several big announcements in the past few days.

  • Giant Eagle enables PayPal and Venmo at all of its 474 stores. This is the first grocery chain in the country that accepts PayPal and Venmo at checkout. To complete an in-store order, users can simply open their PayPal or Venmo app and have the QR code shown in the app scanned by the store cashier. As an incentive to promote the adoption of this feature, PayPal will send $10 in cash back to anyone after they make the first purchase of at least $40 at Giant Eagle
  • ACI Worldwide partners with PayPal to bring mobile wallet options to ACI’s bill clients. ACI Worldwide is a leading company in real-time digital payments with numerous clients in various industries such as consumer finance, government, education, healthcare, insurance, telephone and cable, and utilities. By virtue of the new collaboration, bill payers can now make payments on ACI’s client platforms through their PayPal or Venmo wallet
  • Yesterday, Fiserv announced a new feature that enables business-to-consumer payments deposited to PayPal or Venmo accounts. PayPal or Venmo users will be able receive payments from gig economy companies, insurance firms or tax refunds from the federal governments to their PayPal or Venmo account
  • Last but definitely not least, starting October 1, 2021, the company is going to drop late fees for BNPL customers globally.

PayPal is one of a few companies that are known globally. Anyone that regularly shops online must be familiar with their iconic blue button on online merchants’ checkout page. Strong in processing online payments, PayPal; however, hasn’t been as popular with in-store checkout. Personally, I rarely see a store that accepts PayPal as a payment option. The company is well aware of that weakness and planning to address it. In the very last earnings call, the CEO mentioned that they were going to aggressively go into stores. The partnership with Giant Eagle is proof of that. Even though there are only 474 stores in the chain, this is a great first step. I imagine that PayPal will try to use data acquired from this partnership to demonstrate to prospect partners the benefits of allowing PayPal products at checkout. Plus, grocery is a staple category to consumers. If they are accustomed to checking out with PayPal/Venmo, they will be more likely to use it for other purchases as well.

PayPal has been growing its bill payment service for a while. In the previous earning call, the company cited growing bill payment volume as one of the reasons for its decreasing take-rate. The partnership with ACI Worldwide will likely grow the processing volume yet suppress that take-rate further for the foreseeable future. ACI Worldwide supports around 4,000 customers in the US and according to one study, Americans spends $2.75 trillion a year on recurring bills. Even if this move helps PayPal gain 1% of that volume, that’s another $27.5 billion a year added to the company’s U.S bill payment volume. Given that it processes $350+ billion in a quarter WORLDWIDE for ALL services, I suspect that’s the lift the management will be pleased with. I really like this partnership with ACI. Instead of going out there and going through hoops to work with numerous companies, PayPal can now be available on 4,000 checkout pages in a short amount of time. Bill payments are such a critical function in most adults’ life. Convincing consumers to use PayPal/Venmo to pay bills will create a usage habit that is difficult to break.

Here is PayPal from its 2020 annual report:

Transaction expense is primarily composed of the costs we incur to accept a customer’s funding source of payment. These costs include fees paid to payment processors and other financial institutions to draw funds from a customer’s credit or debit card, bank account, or other funding source they have stored in their digital wallet. Transaction expense also includes fees paid to disbursement partners to enable a transaction. We refer to the allocation of funding sources used by our consumers as our “funding mix.” The cost of funding a transaction with a credit or debit card is generally higher than the cost of funding a transaction from a bank or through internal sources such as a PayPal or Venmo account balance or PayPal Credit.

Hence, the more transactions are funded through bank accounts or PayPal balance, the better it is financially for PayPal. Asking consumers to transfer funds from a checking account to a PayPal/Venmo before making a purchase using that balance is futile. It’s inconvenient and cumbersome. The collaboration with Fiserv helps PayPal go around that challenge. Additionally, having a balance motivates users to be more active. If a friend of mine sends $50 to my PayPal account, I will be more willing to use it for my next purchase than I would without that $50 balance. A few months ago, Square bought the tax business of Credit Karma and integrated it into Cash App. I wrote in my thought on the acquisition

In essence, it benefits Square when customers have balance in their Cash App. The more balance there is, the more useful Cash App is to customers and the more revenue & profit Square can potentially earn. I imagine that once Credit Karma’s tax tool is integrated into Cash App, there will be a function that directs tax returns to customers’ Cash App. When the tax returns are deposited into Cash App, customers can either spend them; which either increases the ecosystem’s value (P2P), or deposit the fund back to their bank accounts. But if customers already direct the tax returns to Cash App in the first place, it’s unlikely the money will be redirected again back to a checking account. As Cash App users become more engaged and active, Square will look more attractive to prospect sellers whose business yield Square a much much higher gross margin than the company’s famous Cash App.

The integration of Credit Karma Tax into Cash App did happen. The same logic can be applied here. In addition to lowering its transaction cost, PayPal benefits in different ways from having more balance in its wallet. Instead of acquiring a tax filing business like Square did with Credit Karma, PayPal collaborates with Fiserv to enable not only tax refunds, but also paycheck deposit or insurance payments. Less capital, more applications. What’s not to like?

The BNPL market is hotter than ever. Recently, Square paid an enormous sum of $29 billion for Afterpay. Merchants are racing to enable the feature due to the fear of missing out. Banks like Citi, Chase or Amex scramble to offer their own BNPL version. Even Apple is rumored to develop its own service for Apple Pay transactions. PayPal launched its PayPal in 4 in August 2020. Since then, the service has processed more than $3.5 billion in transaction volume, $1.5 billion of which took place in the last three months alone. Yesterday, with its policy to drop late fees for consumers, PayPal took a bold step towards gaining more market share in this red hot market.

Let’s talk quickly about how BNPL providers make money. There are some providers like Afterpay or Klarna that allow consumers to break down a purchase into several interest-free payments. To generate revenue, these providers charge consumers a fee for every late payment and merchants a fee that is much higher than the usual interchange rate in exchange for new business. On the other end of the spectrum, there are other companies like Affirm that charge consumers no fees, but levy interest on the purchase. For PayPal, it originally belonged to the first group of BNPL firms that offer interest-free payment plans. As a late comer, PayPal lets merchants use this service at no additional charge, apart from the usual commission rate. Today, to attract the end consumers, PayPal decides to drop late fees, a move that will force other competitors to copy to avoid losing grounds. I expect them to follow suit soon. Late fees only make up 9% of Afterpay’s revenue. The problems for these pure BNPL players are that 1/ they don’t have multiple touchpoints to consumers like PayPal and 2/ they are already not making money. Dropping late fees will make the road to profitability even tougher. For the likes of Affirm, I mean, what can they offer consumers and merchants that PayPal can’t?

All of these developments have one common goal: to make PayPal the go-app application for all things financial for us consumers. Just take a look at the breadth of services that PayPal can offer below. There are few companies that can do the same, let alone having 32 million merchants on the network and a brand name that is widely recognized across the globe.

PayPal's Consumer Services
PayPal’s Consumer Services

I expect in the next few quarters, PayPal will have:

  • A higher TPV
  • A lower take-rate due to more bill payments, P2P, especially from Venmo, the drop of BNPL late fees and less reliance on eBay
  • Higher loss rates
  • Higher cost of transactions simply because PayPal has to compensate the likes of ACI, Fiserv and Giant Eagle
  • Higher marketing expense as % of revenue

However, as a shareholder, I can’t help but feel optimistic about the company’s outlook with these moves. I look forward to hearing the management team discuss the ramifications in the future earnings calls.